(Clark Capital) Overblown fears about unlikely events all too often derail investors’ long-term plans. It’s the client who is afraid to invest in stocks fearing an unrecoverable market meltdown, or the client who won’t diversify because they feel safe owning a large concentration of company stock they inherited.
One way to help investors put things in perspective is to help illuminate the difference between possibility and probability. According to Neil Bage of the behavioral finance coaching firm Shaping Wealth, “Almost anything in life is ‘possible.’ But that doesn’t tell us in any way what the probability of something happening is. The only way to assess real probability is to look at history and data.” He calls this phenomenon probability neglect, and it’s amplified when the situation is emotional.
Here’s an example from everyday life: ask someone if they are more afraid of a shark or a mosquito. More than likely, they’ll think the answer is obvious: a shark of course. They would be dead wrong. While it’s possible that one might suffer a shark attack, mosquitos are orders of magnitude more lethal.
Mosquitos cause more than 2.7 million deaths every year and kill more people in just one day than sharks have in a hundred years.1 But the idea of a shark attack is much more emotionally jarring than a tiny mosquito bite; thus, the shark tops the list as one of the scariest predators and serves as an excuse for people to stay out of the water. Mosquitoes wreak havoc from the diseases and viruses they spread, but usually, they’re just too mundane to notice.
Investors are vulnerable to probability neglect when they let concerns of possible events derail the effects of probable events. Often, clients will think there is an overblown possibility that an adverse event will happen, and these situations tend to be magnified when they are fearful. They tend to discount the strong probability of meeting their goals if they follow a few tried and tested strategies: invest early, invest often, stay invested, and diversify.
Bage at Shaping Wealth provides three helpful discussion tactics to help clients put things in perspective:
Discussion Tactic 1: When a client raises a concern (e.g., dollar will crash, inflation is going to 10%, market will crash 50% when “that guy” is elected), discuss it with them. Show them data or historical examples of what a reasonable probability of that happening is.
Discussion Tactic 2: When the concern is raised, draw the client out. Have him or her explain in as much detail the nature of their concern. Don’t counter-argue with evidence. Let them walk towards a conclusion that’s more detailed than the “gut” feeling they started with. If it’s an unshakable fear, even if completely unreasonable, discuss what can be done about it.
Discussion Tactic 3: Now that we’ve explicitly seen that we elevate emotional understandings of probability over mathematical or “rational” ones, is there anything about your financial planning conversations that you can amend? Are there more emotionally-compelling narratives you can incorporate when discussing risk-reward trade-offs with clients?
You know your clients best, and when deciding which discussion tactic to apply, consider both the client and the situation. For example, a particularly emotional client may not respond to data or historical examples. Like the saying goes, you can’t fight feelings with facts. In the situation of a particularly irate or worried client, start with tactic two: hear them out, listen intently, and ask thoughtful questions that help them arrive at a reasonable conclusion on their own. During this process, they will likely calm down while enlisting the reasoning part of their brain. The more time they spend sharing their worries with you, the more time you’ll have to prepare an appropriate response.
As with most behavioral finance approaches, the goal of these exercises is to help clients avoid making bad decisions in the short term that can have negative long-term consequences. Helping clients regain perspective on their financial concerns can help them stay on course to reach their goals.
